Business Law Basics: A Legal Handbook for Online Entrepreneurs and Startup Businesses
Get Informed, Protect Your Butt, and Build an Incredible Business
James W. Hart, Esq.
Copyright © 2016 by James Hart
The right of James Hart to be identified as the author of the Work has been asserted by him in accordance with the Copyright, Designs and Patents Act of 1988.
All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or otherwise, with the express written permission of the author.
First Printing, 2016
This book is dedicated to my family, who love and support me through all my crazy endeavors (including writing my books!) So to my loving wife Donna, and my wonderful children, Charlie, Sophie (“Po”) and Henry, I love you so much for all you have done for me.
I also write this book in loving memory of my amazing mother and my guardian angel:
Martha Burns Hart
[*Legal Disclaimers *]
The information contained in this book is for informational purposes only. This book is not legal advice and should not take the place of hiring a licensed attorney in your jurisdiction. Laws vary state by state, so it is important to reach out to a lawyer licensed in your state for advice unique to your personal situation. Your purchase of this book does not establish an attorney-client relationship with the author or his law firm.
In addition, the information provided in this book should not be considered a substitute for obtaining legal advice from a qualified attorney. You should not act upon any information contained in this book without first seeking qualified professional counsel on your specific matter.
Readers of this book are advised to conduct their own due diligence when making legal decisions regarding their business. Laws frequently change, and the information and tactics contained in this book should be verified by an independent advisor or attorney of your choice.
The hiring of an attorney is an important decision that should not be based solely upon website communications or advertisements or books.
Table of Contents
A Special Invitation
A Note to the Reader
Who is this Book Written For?
A Tale of Two Entrepreneurs
Part One: Your Legal Foundation
First and Foremost: The Basics
Introducing the Four Horseman
Baby Steps… A Sole Proprietorship
Teaming Up: Is a Partnership Right for You?
Corporations Aren’t So Scary… Or are They?
The New Kid on the Block: LLC’s
How to Make Sense of Your Options
Part Two: The Top 10 Legal Mistakes Made By Entrepreneurs
Big Picture: Failing to Plan Like a Pro
You Named Your Baby What???
Business 101: Don’t Shit where You Eat
Buy Low, Sell High
Grab as Much Real Estate as You Can
If You Don’t Write it Down, It Never Happened
I Can Keep a Secret, Can You?
Don’t Fumble the Ball!
Didn’t Your Mommy Teach You Not to Lie?
Suits are a Great Investment (Not that I’m Biased)
Part Three: Final Thoughts
More Crap You Need to Worry About
About the Author
A Special Invitation
This book contains a lot of great information for entrepreneurs that are just starting out in business. But it is just the beginning.
If you are looking for an even deeper dive into the legal issues that you may face as an entrepreneur, you will want to sign up to receive a free copy of my companion book, which, honestly, has not been named yet! But it is in final editing and should be released in early May, 2016. In that book, I dive deep into how to properly name your business, conduct a comprehensive trademark search, file a trademark application, file your copyrights, draft proper contracts, enter into partnership agreements and much more.
If you would like me to send you a free copy of this book in PDF format, just head over to this website and enter your email address:
I’ll send it out as soon as it is ready to be published.
A Note to the Reader
If you are reading this book, chances are you are either thinking about starting a business, or you already have. This book will give you a broad overview of some of the important legal issues you may face when just starting out. If you fail to follow the practical tips provided in this book, you could and probably are doing a disservice to your business for reasons what will become obvious in the coming sections.
As a lawyer and entrepreneur myself, my life’s work is to help other entrepreneurs build their businesses the right way. I want you to reach your potential for greatness, and this book is just the start.
In this book you will find a very brief introduction into the world of small business law. Whether you are a bricks and mortar business or you work from the beaches of Cabo, there is something in this book that will help you to protect your legal butt.
Alright, let’s get down to it. You probably hate lawyers. I totally get it. For the most part, we suck. We are constantly telling you what you can’t do in your business and why you can’t do it. And let’s be honest, we are pretty damn persuasive, aren’t we?
But can I let you in on a little secret? There’s a reason why we do this, and it’s not to try and piss you off, although I’m pretty sure that is the common result.
It’s because most lawyers in the United States spent at least three years in a law school1 with professors that did nothing but drill into our head all the horrible, terrible legal things that could possibly happen to anyone, anywhere, for not following the law. And after we graduated, we spent several months studying for a multi-day bar exam that further tested us on all the possible scenarios that put individuals and businesses alike in legal jeopardy for their actions.
So can you really blame us for trying to talk you out of all your crazy ideas?
But not in this book (for the most part). This book is different. I’m not here to tell you what you shouldn’t be doing in your business. Rather, the purpose of this book is to share with you how you can do exactly what you want to do in your business, while protecting your legal butt in the process.
This isn’t going to sound like a typical legal text. But I’m not your typical lawyer.
I’m also an entrepreneur. I’ve take an non-traditional path in my legal career. I was never indoctrinated into a traditional law firm setting. While I’ve run my own law firm for over 10 years, I’ve run several entrepreneurial side businesses as well. I’ve had many successes and many failures, and have learned many lessons (both good and bad) from all of them.
My name is Jim Hart and I’m the founding attorney at , a law firm dedicated to protecting the intellectual property of online businesses. Whether you sell information products, consulting services, or physical products online, we can work with you to build and protect your online brands.
In this book I will share with you the methodology that I follow with each and every client of my firm. From initial strategy call and planning, to corporate formation and brand protection, to ongoing legal needs, we will hold your hand every step of the way to insure that all of your legal bases are covered.
Should this book take the place of working with an actual lawyer?
Absolutely not. The issues discussed in this book should be taken seriously, and are frequently complex. This is NOT a do-it-yourself legal guide. This book should be used to educate yourself about the possible legal issues you will face in your online business and arm you with the knowledge you will need to talk comfortably with a lawyer when the time comes for you to hire one.
So here’s the plan of attack. We’ll start by going over who the book is meant for and why they should read it. Then we will take a look at some common business formation structures that you should consider when starting your business. Finally, we will review 10 common legal mistakes that I see from entrepreneurs on a daily basis.
If you are interested in learning more, I am working on another book that will include all the information I’ve referenced so far, in addition to getting into common problem areas such as choosing a name for your business, protecting your intellectual property, contract issues, and much more. You can learn more about this book, as well as sign up for an advance copy for free at http://www.hawthornlaw.net/book.
At the conclusion of this book, I will share with you where you can go to learn more about Hawthorn Law and the services we offer, then we will call it a day. Sound good?
Great, let’s get to work.
Who is this Book Written For?
“He who represents himself has a fool for a client.” ~ Abraham Lincoln
This book is not for everyone. The purpose of this book is to make you a smarter, more informed entrepreneur, not provide you with a DIY Manual for everything related to business law.
If you suffer from “Superhero Syndrome”2 and want to take on all of your legal issues yourself, then this book is not for you. This book is not a “how-to” manual for business law and it is not intended to take the place of a good solid lawyer. Rather, the purpose of this book is to provide you with some inside knowledge of issues you need to be concerned about, and help you when talking to your own lawyer. So first and foremost, this book was written for entrepreneurs that understand and appreciate the value of good advice… and are willing to pay for it.
Second, you will notice that this book is written informally. That’s intentional. If you are looking for a legal treatise written with lots of legal jargon and proofread 100 times so that there are no spelling or grammatical mistakes… chances are this book is not for you.
Finally, if you are stuck in an “old-school” way of thinking, and are unwilling to embrace change in your business – then this book is not for you. By “old-school”, I mean that you are conditioned to do business a certain way, and are unwilling to look at new and different ways to operate your business. If this describes you, you will find no value in this book.
Now that we know who I did not write this book for, let’s take a minute to discuss who I did write it for…
So if you are still reading at this point, I presume that means that something I’ve said so far has resonated with you. Before we move into the meat and potatoes of this book, I want to take a minute and share with you two stories of entrepreneurs and how the decisions that they made very early on in their business shaped the future success (or lack thereof).
A Tale of Two Entrepreneurs
Once upon a time, there were two entrepreneurs, foolish Fred and smart Sally. Both Fred and Sally had great ideas to start an online business selling personal care products on a very popular website called Amazon. Both Fred and Sally were working full-time jobs, dreaming of the day when they could ditch their 9-5 cubicle life forever – and starting this business was their first step towards becoming entrepreneurs and extracting themselves from corporate America forever.
Fred was a dreamer. But he was also an action-taker. He knew that if he would just work hard and fast enough, that he could be successful with his e-commerce business. However, Fred didn’t have any money. Throughout his corporate career, Fred liked to “live in the moment”, and always seemed to live paycheck to paycheck. If only this e-commerce dream would work, Fred could be financially set forever.
So Fred set out to find a supplier of his personal care products. After doing some internet research for a couple of hours, he found a supplier that looked good. Fred immediately ordered some sample product under his personal name and paid for these samples using his personal credit card. His entrepreneurial dream was finally becoming a reality!
A few days later, the samples came and Fred quickly picked one to be his first product. He went back to the supplier and placed an initial order, again under his personal name and with his personal credit card. After placing this order, Fred thought it might be smart to name his new brand. After all, the supplier had asked what the name of his company was, so Fred thought it prudent to come up with a name.
Fred’s initial product was face lotion that was made out of beeswax, so after brainstorming some ideas, Fred decided to name the brand after his father, Burt. Burt’s Beeswax Face Lotion was born. When told about the new venture, one of Fred’s friends asked his whether he had thought to incorporate. Fred thought that sounded like a good idea, but decided he would wait until the company was a little bigger and was earning more money.
A few weeks later Fred’s initial order arrived at the Amazon warehouse. Fred put up a listing and the sales started coming in. Fred was ecstatic. His first test order sold out in about a month. Fred received enough in funds from the sales to pay back his credit card, but decided to reward himself with some nice dinners and a new car instead. None-the-less, the end of his corporate job was near!
Over the next few months, sales remained strong. However, because of his careless spending, Fred stopped paying off his credit card completely each month, and was quickly reaching his spending limit. But no fear, Amazon noticed the strong sales for Fred’s brand and offered him a line of credit.
Fred decided this was too good of an opportunity for him to pass up. He maxed out the line of credit, and expanded his product line from just face lotion to lip balm, and some other moisturizers. Sales continued to increase from month to month, and Fred was loving life. He even decided that now he could afford to quit his job… so he did.
Then one day… Fred came home to find a certified letter from a fancy sounding law firm. The letter was several pages long with lots of legal sounding jargon. Stuff about trademarks, violation of intellectual property, etc. They wanted him to stop selling his products immediately, and remove his inventory from Amazon. Fred’s heart sank… surely this was a mistake?
While Fred was trying to get his head around what this letter meant, and how he would manage to keep his brand afloat, his doorbell rang. Fred opened the front door to find a sheriff who handed him some papers and told him that he had been served. Apparently, many of the people using Fred’s face lotion had developed severe rashes that left scarring on their faces. A law firm had decided to sue Fred for damages.
Fred was in a bad place. By failing to conduct a name search and trademark his brand, he was inadvertently infringing on another brand’s trademark. And by failing to incorporate his business or purchase insurance, he was at risk of losing not only his business, but his home, car and more. Because of these mistakes, Fred’s entrepreneurial venture was short-lived…
Now let’s take a look at Sally, and what she did to start her business the right way.
Like Fred, Sally was also a dreamer. But Sally was also conservative with her money and very cautious with how she invested it. Although Sally also hated her 9 to 5 job, she had made a point of living very frugally and saving part of every paycheck for a rainy day. This gave her the financial cushion she needed to not only launch her e-commerce business, but also to live for 5-6 months on her savings if she lost (or decided to quit) her job unexpectedly.
Sally believed in building her business the right way. Even before deciding to launch her e-commerce business, Sally had begun studying what she needed to do to protect herself legally. So when she developed an idea for a brand of skincare products, she understood that she would need to take her time gathering information about various products and suppliers before settling on a product to sell. Sally spent hours online, researching various suppliers and FDA requirements for skincare products. She wanted to make sure that whoever she decided to work with was properly vetted and made a safe product that could stand up to FDA scrutiny and minimize the potential for a future lawsuit.
Sally eventually found 3 suppliers that had products she thought would sell well and had few competitors in the marketplace. She used her own savings to order samples from each supplier. After receiving the samples, she tested them on herself and gave out samples to her friends for feedback. After settling on a product that she really liked, and which her friends enjoyed also, she decided it was time to place a small test order.
Before placing this order, Sally called an attorney to determine what legal issues she should be aware of before she moved forward. Her vision was to create a national brand that would eventually make its way into retail stores and which she could sell through her own website. Selling the company and the brand was her ultimate exit strategy.
With the help of the attorney, Sally formed a limited liability company. Before she could do this, she needed to name the brand. Because she wanted to build a national brand, she was able to get advice and guidance from her attorney on the proper types of names she should consider for her brand.
Although it added some delay to her initial order, Sally settled on a name for her brand that her attorney helped her to “clear” and which they both agreed would be easily trademarked.
Next, Sally hired the lawyer to form the LLC for her, and she used her corporate documents to open a bank account for the business and apply for a tax id number. After funding this account with her personal funds, Sally settled on a supplier, and placed a small, initial order of product, using the LLC account to complete the purchase.
While waiting for the products to ship, Sally hired an independent contractor to design her company logo and had her lawyer file an “intent to use” application for her trademarks. In addition, she had the lawyer draft an appropriate disclaimer for use on her packaging and purchased UPC codes to place on her labels. She also purchased a products liability policy for the business (using the business bank account to pay for the policy).
It took a little longer than Fred, but within 2 months, Sally was in business. She continued to work her day job and worked on her e-commerce store at night and on the weekends. Within several months, her sales began to ramp up. With the exception of paying herself back the money she used to fund the business, Sally took no cash out of the business. Instead, she built up her cash reserves and reinvested her sales proceeds into more inventory, marketing and developing new products.
Within a year, Sally’s trademark application was approved and her business was humming along. Eventually, Sally did quit her job, and her future looks bright as several companies have approached her with offers to purchase her brand (they were attracted to her brand name and the licensing possibilities that stemmed from her trademark registration) or place her products in their stores.
Why was Sally successful where Fred failed?
Both Sally and Fred built nearly identical businesses. Sally’s was a true success, and Fred’s ended up in bankruptcy. But why? What could Fred have done that would have allowed his business to thrive?
Sally took a logical, step-by-step approach to her business. She didn’t rush the important decisions, but treated her business with the respect that a startup deserves. Fred viewed his business as a “get rich quick” opportunity. When the sales started coming in, he was blinded by his own greed. He failed to do any planning at all, including researching proper names for his brand (one of his biggest mistakes), and spent recklessly on credit rather than reinvesting his cash into the business.
By failing to seek the help of a lawyer, Fred put off some of the most important things he needed to do, such as form a legal entity and purchase insurance. His naming issues aside, forming a legal entity and purchasing insurance would have allowed his business to stay afloat while he negotiated with the lawyers on how to rectify his naming problem. He could have made it.
The big lesson here is that taking some easy, relatively inexpensive steps early on to build a solid legal foundation for your business can pay huge dividends later. And failure to plan can quite literally bankrupt you.
Let’s learn more about some of the topics discussed in these case studies.
Your Legal Foundation
Everything you need to know about forming a corporate entity
Business Law Basics
This is where the book is going to get a little technical – but that’s ok – you need to know this stuff.
You’ve taken the plunge and made the decision to start an internet-based business, which means you need to start thinking about business entities.
Let’s be honest, in today’s world, there is really nothing more exciting and thrilling than the idea of becoming your own boss, controlling your own destiny, and building your “freedom business”.
Seriously, who doesn’t want to work from the comfort of their own living room (or anywhere on earth so long as you have an internet connection), sipping coffee in their pajamas, with only a laptop and cellphone, working a “4 hour work-week”3
It’s exciting. It’s cool. And it’s in vogue right now. But at the end of the day, there are a lot of legal hiccups that can get in your way and derail your dreams.
For starters, let’s start with looking at your choice of business entity.
The Four Main Business Entities
There are four main legal entities that will satisfy the needs of most internet entrepreneurs – sole proprietorship, general partnership, corporation, and limited liability company. Let’s take these one-by-one. For each, I’ll briefly discuss what they are, their main advantages, their main disadvantages, and who they would work well for.
As always, if you aren’t sure which entity to choose, it is important that you consult with a legal professional to go over your options.
What is it? A sole proprietorship is the simplest type of business entity there is. It’s essentially the default choice if you don’t elect some other entity. Anyone who is running a business but hasn’t filed documentation with their local secretary of state to incorporate is considered a sole proprietor. Notwithstanding, you may still need to apply for and receive certain licenses and permits to do business, depending on the rules and laws in your jurisdiction (that’s a legal way to say “the city/state where you conduct business”).
Main Advantages. The biggest advantage to operating a sole proprietorship is that there is no cost (other than permits/licenses mentioned above) and no paperwork to file. The owner of the proprietorship will report their income or losses on their personal tax return under Schedule C of Form 1040.
Main Disadvantages. As a business owner, you are subjected to unlimited personal liability for the debts and other liabilities associated with your business. This is where Fred made a big mistake by failing to incorporate. As a sole proprietor, if you were sued by a creditor for debts you took out for your business, or for liability attributed to a course or product you sold online, then you stand to lose not only your business assets, but your personal assets as well, including your house, car, bank accounts, etc.
Who would make a good sole proprietor? In my opinion, there are not many good candidates to be sole proprietors. The main reason for this is the unlimited personal liability. Even if you think there is no chance you would ever be sued, and you don’t have any business debt, I still recommend that most online entrepreneurs form some type of corporate entity.
What it is? A general partnership is a sole proprietorship that is operated by two or more people. For example, let’s say you and your best friend (not your spouse) decide to start a business selling products on Amazon. If you don’t elect a formal business entity, you have basically formed a general partnership and you may not even know it. In those situations, you could still receive some legal protection in the form of the[+ Uniform Partnership Act (UPA) or Revised Uniform Partnership Act (RUPA), which has been adopted in all states except Louisiana+] (the RUPA has only been adopted in 37 states, and varies by state).
Main Advantages. Like a sole proprietorship, it is inexpensive to start up and costs virtually nothing to maintain. Each partner will report their share of the income or loss from the partnership on their personal tax return. You don’t need to draft a partnership agreement to form a partnership, but it is highly recommended because of the informal nature of the entity.
Main Disadvantages. You can be in a partnership and not even know it. In addition, you can be held personally liable for business debts, even if you didn’t personally incur the debt or even know it existed. Without a partnership agreement in place, you could be subjected to virtually unlimited personal liability for the debts and actions of your partners.
When is a general partnership a smart idea? Rarely. Without a partnership agreement in place, you can still rely on the UPA or RUPA, depending on your state, for limited protections. However, we still discourage clients from proceeding without a written agreement. But even with a good partnership agreement in place, you will still be subjected to personal liability for your share of the debts of the partnership.
The vast majority of our clients, especially those that are making money (or anticipate making money), will elect to form either a corporation (C-Corp or S-Corp), or a Limited Liability Company. There are advantages and disadvantages to each, and we’re going to cover both in the next section.
Any discussion of corporations must start with the understanding that a corporation is a legal entity separate and apart from the person who owns the corporation (i.e. the “shareholder”). Any business you patronize, from a restaurant chain like Starbucks (where many online entrepreneurs work…and I don’t mean as employees), to a big box store like Target, to the Honda dealership where you bought your car, is a corporation.
The real advantage to corporations… limited liability.
The biggest advantage of forming a corporation is that you, as a shareholder, will have limited personal liability for the debts and actions of the corporation. This means that if the corporation gets sued, and a judgment is entered against the corporation, you as shareholder would not be held personally liable for the judgment.4
NOTE ON LIMITED LIABILITY: You should be aware that if you do form a corporation and you try to get a loan from a bank or other creditor, it is highly likely that you will be asked to sign a personal guarantee – meaning that you could be liable on the debts of the corporation regardless of the fact that you are an individual separate from the corporate entity.
Types of Corporate Entities. There are two types of corporations, C-Corps and S-Corps. There are significant differences between the two that you need to be aware of before you organize your online business as a corporation.
C-Corporations vs. S-Corporations
What are the differences? Both C-Corporations and S-Corporations are completely separate entities from a legal standpoint then their shareholder owners, and both file their own Federal and State tax returns. A C-Corporation also pays it’s own taxes on its net profit, while an S-Corporation files an “information return” and the net income flows through to the shareholders in proportion to their ownership interest.
Tax Treatment. The main advantages to operating as an S vs. a C-Corporation, or vice versa, are the tax benefits or drawbacks of each, depending on your unique situation. Since a C-Corporation pays its own taxes on net profits, (even profits that are distributed as dividends, which you must also pay taxes on at the personal level; this is known as “double taxation”), you must consider the corporate tax rate vs your personal income tax rate in making this decision. In addition, an S-Corporation passes both income and losses through to the shareholder owner. That means that in the early stages of a business, you can use those losses to offset income from other sources on your personal tax return. A C-Corporation will not pass on losses to shareholders.
Opportunity to Lure Investors. As an S-Corporation, you are limited to 100 shareholders. A C-Corporation, on the other hand, can attract unlimited investors. Based on your growth projections and how you plan to finance your business, a C-Corporation may make more sense if you are looking to investors for financial backing or if you are considering “going public”. If, on the other hand, you intend to remain small and “bootstrap” you business in the form of retained income, personal loans, or possibly friends and family, then an S-Corporation may make more sense. For many businesses, it makes sense to start as an S-Corporation and switch back to a C-Corporation if your business takes off.
[_Note: _]If you intend to seek investors, you will need to comply with both state and federal securities laws. Failure to do so can have dire and severe ramifications for you personally and for your business. Anything from hefty fines to jail time are possible if you make a mistake here. You will definitely want to seek the advice of a securities lawyer before taking money from investors (or seeking it).
[*Disadvantages to forming a Corporation. *]The biggest disadvantage is following all the deadlines and complying with the requisite corporate formalities so that you don’t risk losing the liability protection that the corporate veil offers. This means you have to timely file your annual reports, hold your annual meetings (even if it is just you), etc. You will want to start and keep a corporate binder (or online file) that holds all of the important legal documents related to your corporation, and make sure you don’t miss any filing deadlines or requirements in your state.
Limited Liability Companies (LLC)
The last form of business entity that we need to discuss is the LLC. An LLC is a sort of hybrid business entity that has a lot of flexibility in how it is taxed and managed, while still maintaining the limited liability of a corporation.
Main Benefits. The main benefits to doing business as an LLC are that 1) it enjoys limited liability, just as a corporation does, 2) you can elect to be taxed as a partnership, a C-Corporation, or an S-Corporation, depending on your personal situation, 3) it allows for a flexible management structure, meaning that the LLC can be run by a single member, joint members, or even an outside management company, and, 4) the members of an LLC can distribute profits and losses anyway they wish, regardless of the percentage ownership of each member.
Main Disadvantages. An LLC has reduced opportunities to receive tax benefits from the payment of certain fringe benefits that are paid to owner-employees of a corporation. In addition, you cannot offer stock to LLC employees as incentive compensation, because LLC’s don’t offer stock, they have “membership interests”. For this same reason, LLC’s cannot introduce a stock offering to the public at large. Note that you can give an equity interest in the LLC, but you just can’t call it “stock”.
Limited Liability Companies (or LLC’s) are almost the default choice for new businesses these days, regardless of whether it is the right choice for your business. Believe it or not, an LLC, while beneficial in a lot of situations, is not a one size fits all solution to your business forming needs.
So what is an LLC, and should I form one?
An LLC is a hybrid type of legal entity that provides for limited liability, similar to a corporation, but also allows for flexible tax and management structures. An LLC is formed by choosing a business name (that is available in your state), and then filing Articles of Organization in the state in which you do business. In addition, you are likely to need an operating agreement, especially if you are forming a “multi-member” LLC, which is exactly what it sounds like – an LLC with more than one owner.
After you have gone through all the corporate formalities, there are some secondary steps you will need to take to form your LLC properly, which include:
Obtaining the proper licenses and permits. Every city and state has different requirements, but many require you to obtain some form of business license and/or permit to do business. Here is a handy resource from the Small Business Administration that can help you find the requirements for your particular state.
Announcing your Business. Although rare, some states require you to take an additional step and publish a statement in your local newspaper letting the public know that you have formed a new LLC. Some of the states that require this include Arizona and New York. This is an added expense that you must consider if you choose to form an LLC in those states.
What taxes must an LLC pay?
One of the main benefits of forming an LLC is that the business itself is not subject to it’s own income tax, like a corporation. Instead, an LLC is considered a “flow through” entity for income tax purposes. This means that the income from an LLC flows through to the business owners and is listed on their own personal tax return.
However, the inherent flexibility of the LLC allows its owners to choose how to be taxed. If you are a single-member LLC, then you can simply report your income (or loss) from the LLC on your personal 1040. Alternatively, you can file a form 8832 with the IRS and elect that your LLC be taxed as an S-Corporation. In that situation, you would need to file an “information return” (Form 1120S) with the IRS in addition to your personal tax return.
Keep in mind that if you choose to elect S-Corporation status, you must do so within the first 2 months and 15 days after the LLC is formed, or after the beginning of the tax year in which the election is to take effect.
LLC’s that are run as partnerships can also elect to be taxed that way and will file a partnership tax return (Form 1065), just like a traditional partnership would.
Advantages and Disadvantages of Forming an LLC
The biggest advantage of filing as an LLC is the limited liability it provides to it’s owners. This means that the members of the LLC cannot be sued personally for the business debts or liabilities of the LLC.
Other main advantages of filing as an LLC include less regulatory requirements, as compared to filing as an S or C Corporation. Although I recommend it, you do not need to have an annual meeting of shareholders or keep up corporate books/minutes to maintain your LLC status. Also, the members are free to divide up the profits however they choose, as opposed to dividing them in proportion to their ownership interest (as is required by S-Corporations).
One of the main disadvantages of filing as an LLC is the requirement that the member owner pay self-employment taxes on the net income of the business. In an S-Corporation, the net profits are excluded from self-employment taxes, so long as the shareholders take a reasonable salary. If you are making more than $50,000 per year from your business, this is a significant disadvantage to an LLC.
In addition, there can be substantial extra fees in some states to have an LLC vs. an S-Corporation. In North Carolina, for example, you must pay a $200 fee every year you keep the LLC and file an annual report. There is no such requirement for an S-Corporation.
Which Corporate Entity Should You Choose for Your Online Business?
As you can plainly see, the decision to incorporate vs. form an LLC vs. stay put as a sole proprietor or partnership is not an easy one. The decision is complex and there are lots of “moving parts.” You must consider the potential costs of incorporating, versus the likelihood that you would like to offer stock to employees or the general public, versus the risks that your business will be sued.
This isn’t a one-sized-fits-all decision. If you are considering forming a business, we highly recommend that you seek out the professional advice of an accountant or attorney to help you navigate these waters.
The Top 10 Legal Mistakes Commonly Made by Entrepreneurs
Big Picture: Failing to Plan Like a Pro
Why do so many entrepreneurs act like amateurs? The fact that you are reading this book means you are light-years ahead of other entrepreneurs out there.
Have you ever heard the saying, “if you fail to plan then you plan to fail?” In term of starting a business, truer words have never been spoken.
I see this time and again. An entrepreneur comes up with a great idea, they jump into production mode without properly vetting the idea and confirming that it is something that the market needs and wants, and then they end up crashing and burning. Distraught, they head back to their day job and dream of what could have been.
There is a reason why half of small businesses fail within the first year of operations, and only one-third make it ten years of more.5 More likely than not, the high failure rate is due to poor planning.
I’m not suggesting that you need to run out and write or commission a detailed and expensive business plan for your business. Very few businesses actually operate with a business plan in place. What I am suggesting is that you at least do some research to validate your idea before you invest a significant amount of time and money into your venture.
Entire books (, by Pat Flynn and , by Ryan Levesque) and courses () have been written about how to properly vet your business idea to insure your success before you start your business. For that reason, I’m not going to get into the details of how to research your business idea here.
But suffice it to say, pick up one of these books or invest in a course like Zero to Launch before you launch your business. It will be time and money well spent.
You Named Your Baby What???
Yeah, we never say that do we? But we all know someone who named their child something where you just have to scratch your head and say… “what a beautiful name!”
I come across this a lot with entrepreneurs that want to trademark their names and have already branded their entire business without consulting with a lawyer.
Entrepreneurs severely underestimate how important the choice of their business name is. It can literally be the difference between long term success and utter failure. But the important question on your mind is probably, “why does this matter so much?”
To answer that question, I will touch briefly on the two ways that people can pick a bad name for their business. The first involves picking a name that infringes on someone else’s intellectual property, and the second involves picking a name that is incapable of being protected as your own intellectual property.
Picking a Name that Infringes on Someone Else’s Intellectual Property
It seems so simple and so basic that you would never pick a name that violates someone else’s intellectual property. But yet it happens again and again and again…
This topic is so important that I’ve extensively on both how to pick a correct name for your business, and how to conduct a comprehensive name search to insure that you are not violating anyone else’s intellectual property. If you are interested in reading about these topics, you can download a copy of my companion book with those chapters for free at http://www.hawthornlaw.net/book.
For whatever reason, there are still entrepreneurs that insist on starting a business, finding a cool sounding domain, and then moving forward with their business without properly vetting the name they have chosen. Doing this could land you in hot water in the form of a nasty cease and desist letter, or worse… a lawsuit in Federal Court.
Either of those options come with expensive ramifications, not just in terms of paying lawyers to defend you, but also in terms of the costs and time associated with renaming your brand and losing all the brand equity you had built up in your business.
Remember our friend Fred at the beginning of this book? This was one of the many mistakes that he made.
Picking a Name that You Cannot Trademark
When attempting to trademark a name, there is a spectrum of different types of names of varying degrees of “trademark ability ”that have been pre-defined by the federal courts. Some names are more easily trademarked than others. In general, the classifications run from fanciful and arbitrary names to descriptive and generic names. The fanciful and arbitrary names are the most likely to be trademarked, while generic names cannot be trademarked. While descriptive marks can be trademarked, they must acquire secondary meaning in the marketplace first, meaning they are not a good name to start with as you are building your business (unless you have no interest in trademarking your name, but what fun is that?)
Many entrepreneurs run straight to descriptive or generic names because they want their target client or customer to be able to easily understand what it is that they do. I realize this seems counterintuitive, but from a legal perspective, for anyone that wants to build a brand, this is not a good idea.
To properly protect your valuable intellectual property, you need a name that is uncommon or even made-up. Suggestive names are also very strong. Will it take longer for people to understand your company and what you do? Perhaps. But at the end of the day, there is less likelihood that you will infringe on someone else’s trademark by doing this, and your trademark application should breeze through to final registration.
For more information on how to pick a strong name for your business, visit http://www.hawthornlaw.net/book.
Business 101: Don’t Shit where You Eat
I’m not talking about sleeping with your co-worker, but this is almost as bad. (And if you are a startup and aren’t married to your business partner, probably best to not do that either).
What I’m referring to here is co-mingling your personal funds with your business expenses (if you were smart enough to read through Part One and form a legal entity), or even worse, failing to form a legal entity and just using your personal funds and bank accounts for the business.
I totally get it. You’re a startup. You’ve got shit going on (i.e. you’re busy). You don’t have time to meet with a lawyer or accountant to figure out what type of legal entity you need to form, much less the capital to pay for this advice.
So what do you do? One of two things. First, you do nothing and just use your personal bank account for the business. Even though you think you are doing nothing, this is still a choice and you are now running your business as a sole proprietorship. This was the choice that Fred made and how did that end up for him when he was sued?
By doing this, not only are you losing out on valuable tax benefits that come from incorporating your business or forming an LLC, but you also could be subjecting yourself to personal liability for the obligations of the business.
In addition, if you have your eyes on selling your business in the future, you want to put the proper foundational structures in place now to make your business more valuable in the eyes of potential buyers. Forming a proper business entity is a great way to start out and show the world that you have a legitimate business, not just a hobby.
Buy Low, Sell High
Getting your intellectual property protected early on is like buying a stock at pre-IPO pricing. It’s about the cheapest investment you can make into your business and will provide the biggest return over time.
Unfortunately, I get a strong sense that for many entrepreneurs, protecting their intellectual property is an after-thought. It’s something that they will “get around to” after their business is successful and they have money in the bank.
This is a poor choice, and if you fall into this camp, I suggest you strongly reconsider your position.
Here’s the deal. If someone wants to steal your intellectual property, they aren’t going to do it when your business is just starting out and nobody has heard of you. They are going to do it after you start to gain traction and have become recognized in the marketplace. Not only that, it takes a minimum of 9-18 months to trademark your brand – assuming there are no problems along the way.
So wouldn’t it make sense that you get your IP protected early in the process so that just as you are picking up steam, your trademarks get registered and then you have nothing to worry about?
What about if there is a problem with the application – wouldn’t you want to know that early on so you can pivot your name, rather than after your brand is selling well in the marketplace? When filing a trademark application, most lawyers (ours included) will conduct a comprehensive name search first. Wouldn’t you want to be aware of any potential conflicts as early as possible?
Finally, what if someone comes in and wants to purchase your brand. To do so, they need assurances that you have protected all of your IP. Wouldn’t that be a bummer if a sale fell through because you hadn’t yet filed your trademark applications?
If you would like more information on how to get started trademarking your brand, visit http://www.hawthornlaw.net/trademark.
Grab as Much Real Estate as You Can
You would probably be hard-pressed to find an online entrepreneur who isn’t using some sort of social media account these days. So when I say real estate, I really mean social media accounts. Once you have settled on (and properly cleared) a name for your business, the next step is to grab as many social media accounts with your future brand/company name as you can.
I’m not suggesting you need to start using all these accounts, just claim them. You may be just starting out using Facebook or Twitter for example, but you still want to grab your brand name account for Snapchat, Instagram and Pinterest, for example.
So go ahead and grab all the social media profiles you can. Even if you don’t use them – that’s ok. Also, this is yet another opportunity for you to identify whether there are other brands out there already using the name you are looking to register as your own trademark.
If You Don’t Write It Down, It Never Happened
One of the most important things you can do in your business is to write things down. From a business standpoint, you want to document how you do things (i.e. your “systems”) so that you can hand off what you do to new employees. But from a legal standpoint, you must reduce all of your legal relationships to writing.
Many entrepreneurs underestimate the need for good contracts in their business. Whether you are selling products online (either physical or information products) or providing consulting services, you must have a valid contract in place that can protect you from your customers.
But that’s not all….
Do you work with vendors? You need a contract.
Do you hire employees or independent contractors? You need a contract.
Do you work with affiliates? You need a contract.
Taking on partners? Don’t even think about starting your business without a partnership agreement in place.
Seeking investors or want to grant ownership to employees or contractors? You absolutely need a contract.
I think you get the idea by now. Contracts protect you in places that the law can’t or won’t. A well-written contract will outline all the terms of the business relationship, including the following:
Pretty much any scenario you can think off can be (and should be) covered by a valid contract. You may have a verbal agreement with someone, but when things go south all bets are off.
Remember the movie Jerry Maguire? There is a storyline where Jerry makes a handshake deal with the father of the number one pick in the NFL draft to be his agent. The father says to Jerry, “you know I don’t do contracts, but what you do have is my word… and it’s stronger than oak.” As can be guessed, later on in the movie the father and his sign decide to sign with a competing agency.
Don’t make the same mistake that Jerry made. Get all your agreements in writing. You’ll sleep better knowing you are protected.
“I Can Keep a Secret… Can You?”
Did you ever have that really good friend in high school that swears they won’t tell if you share an embarrassing secret with them? They are your best friend – there is no way they would reveal this secret… so you tell them. Mysteriously, the next day your start hearing rumblings in the hall. A rumor is circulating about the story you told your “friend.”
If you haven’t figured this one main idea out yet, then read carefully. I’m very big on helping you to protect your intellectual property. Intellectual property is information that comes out of your head that you use in your business. If you decide to share your secrets with someone else without legal protections in place, you can be sure that somewhere, somehow, this information will get into the wrong hands and come back to haunt you.
You need to outline and write down what this information is, and who should have access to it. Then you can restrict who has access to that information.
Whenever you are dealing with or handling confidential, proprietary information related to your business, you must have a valid non-disclosure agreement in place.
So what is a non-disclosure agreement?
Here’s the Wikipedia definition, which is actually pretty accurate:
“A non-disclosure agreement (or “NDA”) is a legal contract between at least two parties that outlines confidential material, knowledge, or information that the parties wish to share with one another for certain purposes, but wish to restrict access to or by third parties.”^6^
[*What will an NDA do for you? *]
The entire point of the NDA is to protect you or your business from having a third party steal your intellectual property. So if you are negotiating with a certain vendor to manufacture your product, you may want an NDA in place so that the vendor can’t use this information to manufacture counterfeit products to sell to your competitors. Alternatively, NDA’s can be used to deter or prevent students who take your online course from disclosing the information that receive in the public forum.
When we are drafting terms of service or other client contracts, we typically include a non-disclosure provision within the contract itself as a separate clause. However, it is also common to see NDA’s as stand-alone contracts as well.
Don’t Fumble the Ball (at the Goal Line)
I’m from Cleveland, which means I’m a die-hard Browns fan. Its the cross I bear in life, I suppose. But every Browns fan that was alive in 1989 (and even some that weren’t), remember “The Fumble.” Cleveland was playing Denver with a trip to the Super Bowl on the line. The Browns had fought back and were driving for the tying score. Byner gets the hand off and races into the end zone… the only problem was, he left the ball on the 3 yard line, only to be recovered by the Broncos.
What does this have to do with your business? Everything.
You may have the best website in the world, a website that is set to give you the financial freedom you have been dreaming about (i.e. your “Super Bowl”), but if you don’t take the steps necessary to protect it, you can lose everything.
Don’t fumble the ball by overlooking the legal requirements for your web properties. What does it mean to make your website “legal”? Quite a bit actually.
Here are some of the big problems that I frequently see with websites that you need to be aware of:
And this is just the beginning. I suspect that if you run through this checklist on your own website, you are likely to find at least a couple instances where you are doing something illegal on your website – and you may not even be aware of it.
Didn’t Your Mommy Teach You Not to Lie?
We are taught from a very young age that we aren’t supposed to lie. It’s so engrained in our psyche that most of us don’t even give it a second thought. It’s a given, don’t lie cheat or steal. So why is it then, that when confronted with the opportunity to selling products online, many people throw that invaluable advice out the window just to get a couple more sales?
Unless you are planning to have a very long and costly battle with the Federal Trade Commission (FTC), you absolutely, positively, MUST include a proper disclosures when it comes to any testimonials you have on your website or any affiliate relationships in which you sell products and receive a commission.
The default here is to provide open and honest disclosures to your prospective clients and customers, not to “hide behind the ball” in the hopes that they will sign up without worrying about the disclosures.
Why is this important? For starters, it is just good business. People want to trust who they are doing business with. And if you start out the relationship by at best, withholding information that could impact a buying decision, and at worst, flat out lying to your prospects, then not only are you breaking the law, but you are also building a shaky foundation for your business.
The second reason this is important is that this is what the law requires. The Federal Trade Commission was formed to protect consumers in the marketplace. If you make a claim on your website, or include a testimonial from a satisfied client or customer, you must also include a proper disclosure with that testimonial. Not only that, but you also must include evidence and statistics that back up what the customer said in the testimonial.
This is probably one of the biggest areas where I get push-back from my clients. However, it is also an area that the FTC monitors closely. When you are first starting out and small, you will fly “under the radar”. But as you grow, it only takes one complaint from a disgruntled client or customer for the FTC to open a file.
Sorry, I recognize that this is why many people hate lawyers. But I want you to be protected.
Affiliate disclosures are somewhat easier to manage. You just need to disclose that there is an affiliate relationship and that you may receive a commission if someone buys through one of your links. For best practices, I recommend including a link in the footer of your website, as well as a separate disclosure on any post or page that may include affiliate links.
Suits are a Great Investment (Not that I’m Biased)
When I say that a suit is a great investment, I’m not talking about clothing. Lawyers (and other corporate execs) have long been known as “suits”. Investing in good legal advice is almost never a bad thing. And this is not something you do after you have already gotten into legal trouble. The smartest entrepreneurs have a lawyer on retainer that they can call whenever they have an idea or plan that they want to make sure gets done the right way.
Failing to hire good legal help is a huge mistake that too many entrepreneurs make. If it didn’t seem so self-serving, I would have put this big mistake at the top of the list. I can’t tell you how many times someone comes to me with a legal issue that could have easily been resolved or even completely avoided if they had just sought out the advice of an attorney early on in the process.
Unfortunately, many people believe that a lawyer is a wasted expense unless they have a conflict that needs resolved. (i.e. they are getting sued or need to enforce their legal rights). This is a misguided notion. Lawyers can be a tremendous asset and can save both individuals and businesses alike many thousands of dollars, if not more, in legal fees, damages, taxes, etc. if used as they were intended – to provide valuable counsel about how to properly follow and apply the law to your advantage.
I was on the phone with a woman just today about a matter that is not yet a legal issue for her, but as a result of my help and the information I shared with her, she is able to take affirmative actions now that will have a profound impact on her legal matter when it ultimately becomes an issue for her to deal with.
As a result of my counsel, she can now:
On the other hand, I received a call from a frazzled client yesterday what was upset over a cease and desist letter she just received. She is now worried that her business is in jeopardy and that she may have to file bankruptcy. Why?
To begin with, she picked a bad name (see number 2 above). Her second mistake was using a cheap third party service to attempt to trademark her chosen name. They failed to conduct a comprehensive trademark search that would have revealed this competitor and instead proceeded to file her trademark application without properly counseling her on the risk of doing so without a proper search. After making it to the end stage of the application process (the publication period had almost expired), the competitor jumped in to oppose the application, and then followed up with a cease and desist letter.
The only reason this happened is because the client wanted to go cheap on legal help when she first started rather than get a lawyer involved early in the process. Let’s say that she hired a lawyer to file her trademark application for her, and that this lawyer would have cost her roughly $2,000-$2,500 (not including filing fees). Here is what the client would have saved:
Can you see how the cost of not hiring a lawyer at the beginning of the process clearly cost this client many multiples of the fees that would have been paid to a lawyer?
I hope so.
If it has not yet sunk in with you that hiring a lawyer is a smart investment, then you need to go back and re-read the first nine mistakes that people make one more time.
Now, as we bring this book to a close, I want you to understand yet again that this book is not meant to take the place of hiring a lawyer. The purpose of this book is to give you the information you need to educate yourself about the various legal aspects of starting and building an online business.
If you have any questions at all, I strongly recommend you seek the help of a lawyer experienced in working with online entrepreneurs to answer your specific questions.
If you would like to reach out to us, please use our we would be happy to find a time to talk to you.
Other Potential Legal Issues You Need to Be Aware Of
This book contains a lot of great information for entrepreneurs that are just starting out in business. But it is just the beginning.
Here are few additional considerations for you to think about as you begin to build and grow your business:
If you are looking for an even deeper dive into the legal issues referenced above, many of which you will face as an an entrepreneur, you will want to pick up a copy of my companion book, which has not even been named yet! But it is in final editing and should be released in early May, 2016.
If you would like me to send you a free copy of this book in PDF format, just head over to this website and enter your email address:
I recognize that your time is valuable, and that you are bombarded with an increasingly overwhelming amount of information with regards to staring your online business. You didn’t have to download this e-book, but you did, and for that I want to sincerely thank you.
If you found this material helpful, I would greatly appreciate it if you would consider leaving an honest review on Amazon or your other favorite retailer? Doing so will help this book to reacher a broader audience of entrepreneurs. If you have particular feedback about the book that you would like to share please email me directly at [email protected] and use the subject line “feedback”.
I really enjoyed writing this book, and am already hard at work on my next book, which will dig even deeper into some of the issues referenced in this book, as well as many more. If you haven’t already signed up for my email list, I would encourage you to continue to keep up with my new releases by signing up at http://www.hawthornlaw.net/book , by following me on twitter @hawthornlg, or by liking the Hawthorn Law Facebook page. You can also check out my YouTube Channel here.
Finally, if you are interested in connecting with other entrepreneurs who are on a similar journey building their business, you can check out our private Facebook Community at http://www.hawthornlaw.net/facebook/. On this page, you can share your business successes, ask or give advice, and keep yourself accountable.
Thank you again for your continued support.
About the Author
Jim Hart is a lawyer and entrepreneur. He is the founder of Hawthorn Law, a law firm that works with entrepreneurs of all types to assist them in protecting their intellectual property rights through trademarks, copyrights, contracts, and more.
Jim has been operating his own businesses, both online and off, since 2005, and also consults with other lawyers on how they can build successful law practices.
If you are an entrepreneur and you are looking for additional help and guidance, head on over to our website here:
1. Some states don’t require a law degree to sit for a bar exam, and although law school typically includes three years of study, some law students take longer while others graduate early.
2. Ducker, Chris C. (2014-04-01). Virtual Freedom: How to Work with Virtual Staff to Buy More Time, Become More Productive, and Build Your Dream Business (p. 1). BenBella Books, Inc.. Kindle Edition
3. Timothy Ferriss (2009-11-18). The 4-Hour Workweek, Expanded and Updated. Random House, Inc.. Kindle Edition.
4. There are isolated incidents where a Plaintiff could “pierce the corporate veil” and you could be held personally liable on a judgment against your corporation. However, a good lawyer can help you to maintain proper corporate records so that this won’t happen.
5. https://www.sba.gov/sites/default/files/FAQ_March_2014_0.pdf (Accessed April 5, 2016)
6. https://en.wikipedia.org/wiki/Non-disclosure_agreement (Accessed April 7, 2016)
Business Law Basics is an entry-level legal handbook for online entrepreneurs and startup businesses. Written by intellectual property and trademark lawyer James Hart, “BLB” begins with the stories of Fred and Sally, two e-commerce entrepreneurs with entrepreneurial dreams to break free from their 9-5 jobs. Fred’s story ends in bankruptcy and illustrates many of the mistakes that the author has seen all too often from his entrepreneurial clients, while Sally creates a lasting and successful business by following good advice and covering all her legal bases along the way. From there, Business Law Basics walks you through an extensive discussion of various legal entities, giving the pros and cons of each. You will learn how a properly structured legal entity, can protect you legally and save you money at the same time. So if you want to know more about sole proprietorships, partnerships, S and C-corporations and Limited Liability Companies (LLC’s), this is a tremendous resource. Finally, you will find a value-packed list of the 10 most common mistakes made by entrepreneurs on a daily basis. From failing to plan, to naming issues, to not having contracts in place, this list has it all. So whether you are just starting out with your online business, or you are a seasoned entrepreneurial veteran, this legal handbook will have something in it that you can put to use in your own business today.